Quality, Variety, and Parity: Prices in International Trade
Prices determine allocation of resources in a market economy, yet their role in international trade theory is often underappreciated. In these three essays I provide novel empirical implementations of several theories relating to the prices of traded goods and show the implications for measuring the impact of quality, boosting welfare through increased variety, and explaining exchange rate fluctuations. Chapter 1 uses a variation on the well-known gravity model of trade to show that the observed correlation of export prices with distance is largely due to aggregating across shipping modes. Distance has no affect on free on board export prices once mode of transportation is controlled for; where goods are shipped by multiple modes, the observed distance premium conflates a selection effect with a direct effect. I also demonstrate that the standard Alchian-Allen analysis does not apply if goods are shipped by multiple modes of transportation, undermining an additional theoretical basis for predicting that average quality is increasing with distance in these industries. Thus, prior interpretations of the distance premium as indicating the existence of firm quality differentiation are shown to be largely unfounded. As a whole, the chapter highlights the important and little-studied role of transportation mode, and shows that it has a significant and overlooked impact on traded goods prices. Chapter 2, joint work with David Weinstein of Columbia University and Christian Broda of Duquesne Capital Management, evaluates the importance of countries worldwide gaining access to new varieties of traded goods in an semi-endogenous growth model framework. As producers gain access to new imported varieties, productivity rises and the cost of innovation falls, resulting in the creation of new varieties. These in turn can be exported, thus multiplying the impact on the world economy as a whole. We construct an exact price index that incorporates the effect of variety, using detailed trade data on thousands of markets in a large multicountry dataset, and we confirm that increased import variety translated into a large increase in productivity growth. In turn, this boosted world permanent income by almost a fifth over the decade we analyzed. In Chapter 3, I revisit the debate on exchange rate determination, in particular why the link between changes in prices and movements in the exchange rate seems so weak. I test two hypotheses to ascertain whether previous research failed to confirm purchasing power parity due to misspecification. I find support for substituting import price indices for the consumer price indices typically used, although an additional proposed correction due to the non-continuous nature of the underlying data does not affect the results. This outcome may be attributable to choosing a base country with relatively low variation in its consumer price index. Nonetheless, the paper highlights the importance of focusing on traded goods prices and in doing so shows that the extent of unexplained exchange rate variation is greatly reduced.
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